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Q3 US bank review: fundamentals improving despite revenue pressure

After navigating through Q3, which historically tends to be a difficult quarter, several common themes are beginning to emerge across US money centre banks.

Our thesis on the sector remains intact, with fundamentals continuing to improve despite pressure on revenues. Citigroup was the standout this quarter, but Bank of America lagged.

Several years of the so-called zero interest rate policy are taking a toll on net interest incomes for the sector and forcing the banks into aggressive rounds of cost cutting. Regulation and oversight remains the main driver of industry fundamentals, credit profiles and spread movements. Senior and T2 issuances will likely increase on Orderly Liquidation Authority and Total Loss Absorbing Capital (TLAC) needs. We believe increased loss absorption capital will be positive for our bonds.

P&Ls: Reported profitability did range from 7% of return on equity at Bank of America to 12% at Wells Fargo, which had the help of an outsized $0.9bn of equity gains.

Soft mortgage banking trends came to us as no surprise given further tightening of mortgage standards in the first half of the year, as well as lower volumes. We will be watching these mortgage lending standards closely, as mortgages represent a little less of 70% of US consumer debt and could be drag on GDP growth forcing the US Federal Reserve to keep rates lower for longer.

Core credit metrics continued to improve quarter on quarter, with continued capital build in the quarter ranging from 40bps at JPMorgan to 20bps at Citi. Balance sheets are also displaying higher loans and deposits. Total loans for the top 25 US banks were up approximately 1% from the second quarter of the year, based on the Fedu2019s H-8 data.

Asset quality trajectories: consumer non-performing loans and net charge-offs are making new (cyclical) lows and provisions for credit losses were down quarter-on-quarter. Reserves/loans ratios were down across the board, with Wells Fargo intelligently choosing not to release reserves for this quarter. Citi had a $275m credit reserve build in its institutional clients group, against a $178m reserve release in the second quarter.

Risk-weighted assets are the driver of key credit themes. There will be a significant supply of debt to reach TLAC targets. Goldman Sachs had a sub-par quarter, but is comfortably positioned for TLAC.

The outperformer this quarter was Citigroup. Although it is exposed to nearly all the hot topics, from emerging markets to energy and commodities, Citi beat expectations by controlling expenses and credit losses, as well as relying on other sources of fee income. On the trading side, Citiu2019s performance in equities was better than peers - with its 25% quarter-on-quarter increase the only rise among Bank of America, JPMorgan, and Goldman. Citi noted specific strength in derivatives. Morgan Stanley reports on 19 October.

We now await the filing of the 10-Qs where the most telling highlights will be in the footnotes. We will seek more granular details of exposures to the oil & gas sector.

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Filippo AlloattiSenior Credit AnalystFilippo joined Hermes in 2011 as a senior credit analyst on the Hermes Credit team and specialises in European and US financials. Prior to this he served in a similar capacity at Fortis Investments in the global credit and hybrids group and subsequently at BNP Paribas Asset Management in Paris. Other roles at Fortis included securitisation analyst and regulated utilities and property analyst. Filippo began his career in Germany at Sal Oppenheim & Cie and Berenberg Bank, where he was responsible for derivatives trading and M&A financing. Filippo holds a Bachelor’s degree in Economics & Business Administration from the Universita’ La Sapienza in Rome. Read all articles by Filippo Alloatti